European economy closely linked to Russia

In the wake of the attack on Malaysia Airlines flight MH17 over Ukraine on July 17, we asked Cary Heath, head of the economics and finance department at the University of Louisiana at Lafayette, about why European countries were so reluctant to impose economic sanctions against Russia, which is believed to be behind the violence in that country.

Question: Europe appears reluctant to impose harsh economic sanctions on the Russians, who are believed to be connected to the downing of the Malaysian passenger jet. Why is this? What is at stake?

Answer: Large parts of Europe rely extensively on Russian gas imports: Finland, Lithuania and Bulgaria get all their gas from Russia, and it is the source for about 40 percent of Germany’s supply. That is why EU leaders remain reluctant to impose sanctions on Russia.

Here is a country-by-country review (in local currencies):

Britain: Britain is pushing for a potential “Tier 3” or “sectoral” sanctions on wider sectors of the Russian economy, which could cover areas such as financial services, trade and defense cooperation and energy exports.

• Around 2.5 per cent of Russian imports come from Britain, while the country’s share of the Russian import market currently remains below that of France, Germany and Italy. A third of all British exports to Russia were cars — worth £1.6 billion — with other exports including engineering products, pharmaceuticals, chemicals, consumer goods and education.

• Arms sales would also be hit. Britain has sold more than £86 million worth of sniper rifles, ammunition, drones and laser technology to Russia in just over a year.

• Sanctions would hit the hardest in Britain’s the financial sector. Russian companies are well represented on the London Stock Exchange. London would suffer a disproportionate hit since it serves as Russia’s offshore hub for raising debt and issuing equity.

• Finally, London is a prime destination for Russian businesses. Russian oligarchs are major property owners in London and throughout Britain.

Germany: Germany’s business lobby has been vocal in its criticism of sanctions. Here’s why:

• Germany gets about a third of its oil and gas from Russia, and will clearly resist any serious measures against Russian gas suppliers.

• Germany accounts for almost a third of the EU’s exports to Russia. Russia buys Daimlers, Volkswagens, BMWs and Audis, among other goods, and Germany is Russia’s biggest European investor, with German companies pouring in €16.5 billion last year.

• According to Eckhard Cordes, head of Germany’s Committee on Eastern European Economic Relations, a decline in trade this year was already putting some 25,000 jobs at risk in Germany.

• Total value of bilateral trade with Russia : €76bn

France: France has lucrative defense contracts with Russia, and is very reluctant to support sanctions that might jeopardize them.

• Defense and aerospace remain enormously important exports to Russia.

• France has so far refused to give up a €1.5bn sale of Mistral warships to Russia.

• Total value of bilateral trade with Russia: €18bn

Italy: The Italian government is engaged in efforts to attract foreign investors, particularly Russian, so Italy is lukewarm on the thought of sanctions.

• Italian luxury goods sell well in Russia.

• The Italian Riviera attracts huge numbers of Russian vacationers.

• Overall, Italy is fourth among Russia’s largest trade partners.

• Total value of bilateral trade with Russia: €32bn

Holland: Of the 298 victims on flight MH17, 193 were from Holland.

Still, it is doubtful that Holland will lead the charge for sanctions against Russia.

• The Netherlands is the largest single recipient of Russian exports — 9.2 per cent in total. Outside of the EU, Russia is the biggest Dutch market for flowers.

• In 2011, imports from Russia to the Netherlands amounted to €17 billion and exports to Russia amounted to €6 billion.

• Total value of bilateral trade with Russia: €60bn

Q: Would Russia use its energy as a bargaining chip?

A: The Kremlin probably will not use gas as a diplomatic weapon because this would ravage Russia’s own economy. Furthermore:

• Europe has built up large gas reserves.

• The EU has huge spare capacity for imports of liquefied natural gas, and there is no longer an acute shortage of global LNG supplies. Several pipelines have been modified since 2009 so that gas can be funnelled both ways, reaching most EU areas. Both Poland and Lithuania will be opening new LNG terminals this year.

• If Russian cut off gas to Europe, the West could meet its power needs by a variety of means.

• European countries could fire up numerous idle coal-powered plants. It would take months, not years, to get these old plants online.

• Fracking presents an option for many European nations.

The EU has enough gas trapped in shale to free the bloc from reliance on Russian energy supplies for some 30 years. Last year alone, German consumers subsidized renewable energies to the tune of €20 billion, contributing to an inflation-adjusted 80 percent rise in household electricity prices since 2000.

Q: If Europe and the U.S. imposed harsh sanctions on Russia, could their economy survive?

A: One question not raised is whether China would come to the rescue with loans and trade conduits in defiance of the Western world, if it is shown beyond doubt that Mr. Putin’s proxy forces shot down an Asian airliner.

Cary Heath is head of the economics and finance department in the BI Moody III College of Business.